Buy Swaraj Engines - Microsec

Leading supplier to Mahindra & Mahindra Ltd - A key source to growth: SEL enjoys the access to the India's largest tractor manufacturer “M&M” (41% market share in Domestic tractor industry), which has a holding of 33% in SEL. Swaraj Engines Ltd manufactures tractor engines solely for the “Swaraj Division” of M&M. It caters to ~80% demand of Swaraj division of M&M and rest 20% of demand is met through Kirloskar Oil Engines, which has a holding of 17% in SEL. The demand from M&M is estimated to grow further and reach ~85-90%. The engine volume has grown at a CAGR of 18%, since the M&M acquisition on back of enhanced demand from M&M as compared to CAGR of just 2% over FY04-08 (before the acquisition).

Capacity expansion to improve productivity and help meet the demand from M&M: SEL has undertaken as expansion plan to increase its annual capacity to 75000 engines per annum from 42000 engines in FY11 in two phases. The first phase which increased the capacity to 60000 engines got completed in FY12. The second phase would increase the capacity to 75000 engines. This phase is progressing well and is expected to be completed by CY12. This expansion would help SEL in improving productivity and meet the aggressive engine demand from M&M. The capex of INR55 crore for the expansion would be funded entirely from internal accruals. According to the Management, the capacity can reach 100000 engines as the need arises from M&M.

SEL'S presence in high HP segment and its growth directly dependent on Indian agriculture - An added advantage: Firstly, SEL manufactures engines in the 20-50HP range. Around 10% of sales comes from lower than 30 HP engine, 50% from 30-40 HP and 40% from 40-50 HP. Secondly, SEL's growth has been directly comparable to Indian agriculture. We expect tractor industry to grow in long term on back of more productivity, low penetration, need for mechanization, higher MSPs and policies (NREGA).

Healthy earnings, strong cash flows, zero debt; Valuations attractive: With revenue growth at a CAGR of 21%; PAT growth at CAGR of 26% post acquisition and stable margins at ~15%, the company is poised to grow further and capable of sustaining its healthy earnings. Despite the capex of INR58crore, the company has strong cash flows. Furthermore, the company is debt free and is likely to earn ROE of 26% over FY14e.

Valuation

At the CMP of Rs.430, the stock discounts its FY13E EPS of INR46.19 by 9.31x and its FY14E EPS of INR53.48 by 8.04x. Given such strong earnings, incremental production, leading supplier to M&M, we have assigned a discounted P/E multiple of 9.88x on FY2014E EPS of INR53.48 per share and arrived at a target price of Rs.529 per share for the company i.e. an upside of 23%.

Source : Equity Bulls

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